Yellen has put herself in a corner that's going to be hard to escape

Federal Reserve Board Chair Janet Yellen testifies before the Senate Banking Committee at Capitol Hill in Washington, U.S., June 21, 2016.
Reuters/Carlos Barria
Investors' eyes are turning to the Jackson Hole Symposium later this month. The annual confab of central bankers has traditionally yielded clues about what central bankers might be thinking. But recent data has helped to push Federal Reserve (Fed) Chair Janet Yellen into a corner that she had already painted herself into.

July's U.S. jobs report was unequivocally strong. It was a nice surprise and certainly grabbed the headlines. Friday's headline number increased the three-, six- and 12-month averages, so it must be seen as an indicator of underlying strength in the U.S. labor market and, by extension, the U.S. economy. But the reality is that strong jobs growth is nothing new and it isn't enough to make the Federal Reserve (Fed) hike interest rates in September.

Recent history should tell you that Fed Chair Janet Yellen needs much more. In the last five years, while the headline unemployment rate has fallen by over five percentage points, the Fed has hiked just once. One solitary 0.25% hike. So, in the absence of an outlandishly strong number or a major revision to historical data, it is not going to be the jobs report alone that spurs Yellen into action.

The rest of the report confirms that there isn't anything to worry about with the U.S. labor market. One of the statistics Yellen favors is the underemployment rate. This includes the marginalized and discouraged workers who have dropped out of the labor market for cyclical reasons, but not permanently so. They don't count towards the unemployment rate. These workers have the potential to lift growth without lifting inflation if they can be encouraged back into the labor market. This measure picked up in July, accompanied by an increase in the number of people in the labor market, which suggests that exactly this dynamic is occurring. This will certainly catch Yellen's eye but it bolsters the case to "wait and see" since there's no need to raise rates if there isn't evidence of inflation bubbling up.

Average hourly earnings are improving as the market expected. Wages are growing at around 2.6%. This is the fastest growth we've seen during this recovery but it is still fairly anemic by historical standards. That kind of growth is not going to stir inflation sufficiently to require a rate hike to choke it off.

And so here we are. Most of the conditions that have historically led to rising interest rates are being satisfied. The labor market is strong, the economy is solid (enough) and wages are growing at a safe pace. The truth, however, is that much of this is not relevant. Global economies and financial markets are still feeling nervous, and the U.S. dollar can still send shockwaves across both the Atlantic and the Pacific. It is those factors that weigh most heavily on the Fed Chair's mind.

This is the context to Yellen's dilemma. Financial markets have calmed down sufficiently that they could take another hike from the Fed. But a major reason why markets are calm is because they've discounted the Fed hiking any time soon. It's hard to see how Yellen can box out of this corner.